China’s State Grid shows the way

Given the sensitivity around Chinese investment in ­Australia’s minerals and agricultural resources, a landmark deal due to be finalised this month has attracted ­surprisingly little political noise.

China’s State Grid, a company few Australians have heard of despite it being the world’s largest utility by assets, is buying a 41 per cent stake in South Australian transmission network ElectraNet.

The deal, valued at around $500 million, is modest in size but significant: it marks the first investment by a Chinese firm in Australia’s electricity grid. And if you look at the numbers, it should not be the last.

The state-owned firm is hungry – $US50 billion worth of hungry. At least, that is how much it plans to spend outside of China by 2020 and Australia looks set to play a pivotal role in its global expansion plans.

AFR
AFR

In coming years, NSW, Queensland and possibly Western Australia are expected to privatise more than $40 billion worth of poles, wires and the transmission lines which bring power from generators to homes. The Gillard government’s recent energy white paper estimates there is $108 billion of state-owned electricity assets that should be sold.

While controversial, the privatisation of electricity generators and transmission lines is an inevitable next step in the rush to bolster state government coffers by selling off infrastructure assets such as ports and airports. It may not be the sexiest sector on the block but the stakes are high in the electricity space and the emergence of a powerful Chinese player is a game-changer for the superannuation and pension funds which have dominated bidding up to now.

Electricity assets are attractive to offshore power companies as well as local and international pension funds because they are low-risk investments with long-term predictable cash flows and offer solid returns. Assets like ElectraNet are a monopoly. Governments will also look to select an operator which has a track record of operating electricity assets with the minimum of disruption to users.

The sale of the stake in ElectraNet by Queensland network owner Powerlink was a beachhead into Australia for State Grid which is understood to be eyeing far larger deals. It is also understood to be one of the parties looking at a 42 per cent stake in New Zealand’s second-largest electricity and gas distribution company Powerco, which is being sold by Brookfield Infrastructure Partners.

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Barclays-advised State Grid set about handling its entry into the Australian market in a non-confrontational manner. Politicians and the Foreign Investment Review Board were courted quietly. The deal was also structurally a safe debut into the local market as it did not involve taking full ownership or a controlling stake.

Investment by state-owned entities in Australia is a sensitive issue. State Grid was sensitive in particular of the federal government’s rejection last year of the Singapore Exchange’s $8 billion takeover bid for the ASX Group. That deal was clumsily ­handled and left politicians offside from the beginning.

Opposition Leader
Tony Abbott
used a speech in July to suggest a tougher policy on state-owned enterprises seeking to buy established businesses, which raises questions over how a conservative government will deal with the issue if it wins power next year. However, analysts say that while power prices are a big political issue, the sale of the infrastructure that moves electricity around should not be as sensitive as buying minerals and food supplies for export.

State Grid also got the deal across the line because it was willing to pay enough to get ElectraNet’s other big shareholders on board. It needed to come up with a price that was attractive enough not to convince Hastings Funds Management and Malaysia’s YTL Power to exercise their pre-emptive rights over the stake.

The price State Grid paid for Electra­Net was attractive but not as high as valuations of recent deals. A $500 million price-tag implies an earnings multiple of 9.4 times compared with the average of recent Australian and New Zealand infrastructure deals of about 11 times earnings, sources say.

State Grid was competing with AMP Capital Investors in the process.
AMP
– which wants more exposure to transmission assets – and other underbidders are understood to have since approached the minority shareholders in ElectraNet to buy their stakes, which is not unusual in this kind of deal. Analysts also say foreign investors have an advantage as they are taxed at a lower withholding tax rate of 15 per cent compared with 30 per cent for a local bidder.

Like many Chinese firms, State Grid’s big advantage is that it has access to cheap debt and a lower cost of equity which industry players ­estimate at about 8 per cent. Profit margins in Australia for distributors on the allowed rate of return on debt have also increased as yields on government bonds fall.

Electricity transmission assets offer stable, long-term steady cashflows in a monopoly situation and make sound investments if a bidder’s investment hurdles are lower than the rate of return. While some argue this gives a company like State Grid an unfair advantage, at the end of the day it is good for governments seeking to get the best price possible from asset sales.

State Grid is not only looking in Australia. In its closely-regulated home market, State Grid services 1 billion customers and wants to develop and bring new technology used in high-voltage long-distance power lines to other markets. It has been on a shopping spree in Brazil, Portugal and the Philippines in recent years and has a record of owning both minority stakes and taking full ownership. State Grid acquired $500 million worth of transmission assets in Brazil in May and bought 25 per cent of Portugal’s electricity grid in February.

Other Chinese firms have also been snapping up power asset stakes being shopped around by financially-troubled European governments. China’s Three Gorges bought a $US3.5 billion stake in Portugal’s EDP this year.

Like the pension funds keen to invest in infrastructure assets, State Grid says it is a long-term investor and not just looking to turn a quick buck. The ElectraNet assets are 10 years into a 200-year lease over that network and also expected to expand its wind and renewable energy operations.

The arrival of the Chinese into Australia’s electricity market is the start of the latest shake-up in the nation’s power assets. Australian and Canadian pension funds will be prominent players in the next round of privatisations which has seen major US and UK-based utilities come and go over the past two decades. State Grid is not the first Asian player here, with Hong Kong’s CLP Group active through its Energy Australia subsidiary.

Potential sales in Queensland alone are expected to fetch $17 billion and possible NSW privatisations from 2014 could be worth $20 billion to $35 billion, according to bankers. NSW is in the process of selling $3 billion worth of power plants, something State Grid will not take part in; its focus is transmission assets, which could take 18 months. Poles and wires are not included in that process but could come onto the market in 2015.

While Queensland Premier
Campbell Newman
promised not to sell state-owned power companies in his first term, pressure is growing for a selldown to provide consumers with a more efficient and reliable power network. Most electricity retail assets, except in Tasmania and Western Australia, have been privatised and Victoria largely completed a privatisation process years ago.

The political storm over “gold-plating", over-investment in transmission assets by government-owned operators, has provided ammunition for proponents of privatisation. There are also other potential surprise bidders in the electricity market. Indian and Chinese firms may play a role.